My one regret in the Soho Forum debate with George Selgin–besides the fact that he won according to Oxford rules–is that we didn’t have time to spell out our respective positions a bit more clearly. For example, a lot of people on social media assumed I thought (a) fractional reserve banking was fraudulent and (b) it needed to be outlawed by legislation. I think (a) is way more subtle than a simple treatment allows, while I’m definitely against (b).

In my new Mises Wire post, I explain what Mises’ nuanced views were (and here I draw on excellent documentation provided by Joe Salerno), and then I give this analogy:

In closing, let me offer an analogy. I think that government ownership of roads causes far too many traffic accidents. Under a regime of “free roading,” the number of traffic accidents would plummet, but it wouldn’t hit literally zero simply because the cost of wringing out the last few accidents would be higher than the benefits.

At the same time, Selgin surely thinks that government subsidies currently lead to too much corn being planted in the U.S., and that a regime of “free agriculture” would lead to a lower equilibrium amount of corn. Yet Selgin wouldn’t view the new, lower amount of corn as a necessary evil; he would think it was a boon to consumer welfare.

Thus, even though my views on traffic accidents and Selgin’s view on corn are superficially similar—in that we both think a move to the free market would reduce the amount of each—there is a sense in which my views on traffic accidents are far different from Selgin’s views on corn production.

This contrast is analogous to our views on the same issue, namely fractional reserve banking. Selgin and I both favor a free market in banking, and we both agree that FDIC and the Fed’s “lender of last resort” policy subsidizes credit expansion. Yet I would view any remaining fiduciary media in a genuinely free banking system as a regrettable evil (that caused an attenuated boom-bust if large enough), whereas Selgin would view it as a healthy boon to consumer welfare.

Apologies for repeating a question from the previous thread Bob, but could you expand on your response to Gene’s question to you from the debate. Paraphrasing, how would complete transparency between bankers and demand-depositors modify your position, if at all? i.e. a scenario in which every demand depostor explicitly condones and intends the loaning of their funds on the condition that they can recall the loan at point of purchase via a debit transaction, subject to the risk that their transaction could be declined in the event of insufficient funds on the part of the bank.

If that were the case, and other things remained the same, what would be (if any) the distinction between demand deposits and time deposits?

“In this context, Mises pointed out that commercial banks engaged in fractional reserve banking effectively create money “in the broader sense” (i.e. including not just base money but also money substitutes) and that this money enters the economy through the issuance of new loans. Therefore, unlike (say) new gold flowing into the economy through the spending of mine owners which would be spread across multiple sectors, new money being created through fractional reserve banking is focused entirely on the loan market. Therefore it pushes down interest rates to artificially low levels; they are the first prices to be bombarded with the “credit expansion.”

And as Mises’ quotation from above indicates, he thought this phenomenon occurred with any issuance of fiduciary media. This makes sense, once one understands the nature of fiduciary media. Contrary to the claims of Selgin (which I can’t elaborate here), even in scenarios where the public wants to hold more banknotes, the creation of new money (in the broader sense) entering via the loan market will still cause the interest rate to deviate from its proper level.”

Michael I am going to write another piece on this (either for the blog here or at Mises), and I’ll elaborate. But the quick answer: I think the real issue is whether those claims against the bank circulate in the community “as good as money.” Right now, if I grant a callable loan to an institution, I can’t buy groceries with that piece of paper. But I can buy groceries with my claim against the commercial bank.

But all kinds of contracts can “circulate as money” under the right circumstances. Suppose I let my best customer pay 120 days after she receives product from me provided she signs a transferable note for the amount of their purchase. I then go to one of my suppliers and try to buy product from them with the 120 day note from my customer. My supplier agrees because he also does business with my customer and trusts that the note will be repaid. Will the von Mises police really want to outlaw such activity? Even though my customers note is very “low powered money” doesn’t this transaction make other “high powered money” available for other transactions that would not otherwise be available?

You’re not using your note as money. You’re trading your note for money and using the money to buy stuff from your supplier. You’re just not going through the extra step of having the supplier hand you the money and handing it right back to him for the goods.

You’re example is no different than if you sell your note on the secondary market for cash, and then go buy stuff from your supplier. Only difference being that your supplier ends up with the note in your example, and somebody on the secondary market ends up with the note in normal practice. That’s not the same as using it as money. Neither your supplier, or somebody on the secondary market can turn around and go through a McDonald’s and buy stuff with it. It’s not money.

If you think the note is money, then what happens to your supplier if your customer skips town?

I have used the note to buy stuff from my supplier so, it functioned as money in that circumstance and reduced my need to hold other money or seek other credit. The point is that agreements between private parties can expand credit and affect interest rates.

If the note is convertible to cash on a secondary market it is even more like money. But the fact that I can convert to cash doesn’t change the fact that did not need to covert it to cash when I used it to obtain things from my supplier.

McDonald’s or the corner grocery store provide a very poor acid tests for what is money. Try buying a Big Mac with a $1000 denominated federal reserve note.

My original statement was ” all kinds of contracts can circulate as money under the right circumstances.” It was not ”any promissory note is indistinguishable from a federal reserve note under all circumstances. “

OK, then you agree that the example you provided is not a case where the note is circulating in the community “as good as money”. Sure, you gave an example where you were able to barter a note for goods since the supplier knew the customer and felt like he could take the risk of not getting paid, but you clearly didn’t describe a situation where a note was circulating in the economy “as good as.money”.

Dan no, in the situation I describe the note is absolutely circulating as money and it has filled a need for credit on the part of the mutual customer I describe – the customer with stellar creditworthiness. The note the customer issued is also known as Commercial Paper, Commercial Paper is included in a very broad measure of the money supply: M4. So, the note is absolutely money. I think so, macroecon 101 textbooks think so and every accountant who has included Commercial Paper in a balance sheet entry as a “cash equivalent” thinks so.

My point is if there is a demand for credit “the market” will find a way to supply it. For this not to be so the von Mises police need to prohibit EVERYONE, not just banks, from entering into ANY agreement where goods are exchanged for a written promise to pay a sum of “money” in the future unless the party promising to pay is in possession of the full amount promised. So much for freedom and so much for the wisdom of the marketplace.

Capt., First off, if you read my comments you’ll notice no discussion of making this or that illegal. You also may have noticed Robert Murphy has repeatedly and explicitly said he is not saying FRB is fraud or arguing about the legality of it. This is simply a discussion on what causes the business cycle.

Second off, nobody on the Mises side that I know of is claiming that time deposits cause the business cycle, or that a secondary market for time deposits causes the business cycle. So, you can toss that argument to the side, as well.

The claim is this, from Money, Bank Credit, and Economic Cycles,

“At this point it is important to draw attention to the “time deposit” contract, which possesses the economic and legal characteristics of a true loan, not those of a deposit. We must emphasize that this use of terminology
is misleading and conceals a true loan contract, in which present goods are exchanged for future goods, the availability of money is transferred for the duration of a fixed term and the client has the right to receive the corresponding interest. This confusing terminology makes it even more complicated and difficult for citizens to distinguish between a true (demand) deposit and a loan contract (involving a term). Certain economic agents have repeatedly and selfishly employed these terms to
take advantage of the existent confusion. The situation degenerates further
when, as quite often occurs, banks offer time “deposits” (which should be true loans) that become de facto “demand” deposits, as the banks provide the possibility of withdrawing the funds at any time without penalty.”

So, with that understanding, I’d argue that your example is not a de facto “demand” deposit, and is simply a loan being traded on the secondary market, and it does not meet the criteria laid out by Mises in Human Action that,

“Everything that has been asserted with regard to credit expansion is equally valid with regard to the effects of any increase in the supply of money proper as far as this additional supply reaches the loan rnarket at an early stage of its inflow into the market system.”

Dan no, the claim is money creation is the problem. Quoting Bob Murphy ”Keshav, I don’t want to wade into this big debate you’re having. But the general principle is: If individuals or firms are able to effectively “create money” that hits the loan market early on, then it can push interest rates below the “natural” level and cause an unsustainable boom.”

Capt., if you think commercial paper on its own could cause the business cycle according to ABCT I don’t know what to say. Or if you think trading commercial paper on secondary markets causes it, well, that’s wrong, too. I’d recommend reading Mises.

Just wanted to introduce a helpful qualifier into your guys’ exchange.

The Austrian position is that “the supply of money” can never be excessive or deficient:

Mises, in Human Action:

“… the services which money renders can be neither improved nor impaired by changing the supply of money. … The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.”

This is why fiduciary – not, itself, being money proper – causes the business cycle.

The formula is not that an increase in the supply of money causes the business cycle.

Rather, the formula is that increasing the number of claims *to* money proper beyond the available amount of money proper causes the business cycle.

“The formula is not that an increase in the supply of money causes the business cycle.

Rather, the formula is that increasing the number of claims *to* money proper beyond the available amount of money proper causes the business cycle.”

No, it’s not. It’s what I quoted Mises saying in Human Action, “Everything that has been asserted with regard to credit expansion is equally valid with regard to the effects of any increase in the supply of money proper as far as this additional supply reaches the loan market at an early stage of its inflow into the market system.”

Money proper is the dollar right now. Your definition leaves out the case where a bank prints up a bunch of dollars and introduces that new money into the economy through the loan market. Plus, your definition says nothing about the loan market.

guest,
I’m betting that by “money proper” Mises means something like the monetary base or maybe M0. When I say “issuing commercial paper increases the money supply” or Dr. Murphy says “But the general principle is: If individuals or firms are able to effectively ‘create money’ that hits the loan market early on, then it can push interest rates below the ‘natural’ level.” We are talking about a broader measure of money obviously, because only the central bank can increase the supply of ‘money proper’. I get the point that this broader measure of money might be thought of as multiple claims on the monetary base but my point is you could make FRB publishable by death and still a free people will find a way to create these multiple claims on ‘money proper’ if it is to their mutual advantage (by tendering and accepting commercial paper in the course of an exchange of goods or whatever) so von Mises, despite his loathing of central planning is going to need to do an awful lot of it to keep these multiple claims from happening.

“I’m betting that by “money proper” Mises means something like the monetary base or maybe M0. When I say “issuing commercial paper increases the money supply” or Dr. Murphy says “But the general principle is: If individuals or firms are able to effectively ‘create money’ that hits the loan market early on, then it can push interest rates below the ‘natural’ level.” We are talking about a broader measure of money obviously, because only the central bank can increase the supply of ‘money proper’.”

Dr. Murphy is not talking about M4 when he talks about new money being created. Are you not very familiar with ABCT? Here, check out his discussion with Joe Salerno concerning what Austrians are talking about when they talk about the money supply in relation to the business cycle. I’d also recommend reading those chapters from Human Action that I mentioned before. https://mises.org/wire/how-calculate-money-supply

“I get the point that this broader measure of money might be thought of as multiple claims on the monetary base but my point is you could make FRB publishable by death and still a free people will find a way to create these multiple claims on ‘money proper’ if it is to their mutual advantage (by tendering and accepting commercial paper in the course of an exchange of goods or whatever) so von Mises, despite his loathing of central planning is going to need to do an awful lot of it to keep these multiple claims from happening.”

Just repeating that trading commercial paper causes the business cycle doesn’t make it true. Regardless, the point from the Mises side is that certain actions cause the business cycle, harm the economy, and make it less efficient. Even if you were right about commercial paper being traded causing the business cycle, which you’re not, it would simply show a negative consequence of that act. And considering nobody has mentioned one word about legality, I’m not sure why you seem so fixated on it.

Dan and Dr. Murphy
My assertions are:
1) In the US fiat money scheme, the monetary base would fit von Mises definition of “money proper” and
2) commercial paper would fit von Mises definition for one type “fiduciary media” since commercial paper represents a claim on “money proper.” Being “fiduciary media” commercial paper would of the class of things the creation of which would cause an unsustainable boom according to von Mises.

Capt Parker, Salerno spelled out quite clearly the components of the quantity of money:

Rothbard developed a U.S. monetary aggregate based on the theoretical definition of money as the general medium of exchange. Rothbard elaborated on this definition in an article published in 1978 and in his book, Mystery of Banking, published in 1983. In creating this new monetary aggregate, Rothbard aimed at capturing the supply of dollars instantly accessible for spending by the public. Thus he included all currency outside bank vaults plus deposits at commercial banks and thrift institutions (savings banks, saving and loan associations, and credit unions) that could be withdrawn on demand at par value. These deposits naturally included all checkable deposits but also all savings deposits. Rothbard also added U.S. and foreign government deposits at banks and the Federal Reserve, which had been routinely included in the money supply by most economists before World War 2. More controversially, Rothbard included the cash surrender values of life insurance policies, that is, the savings component of life insurance policies that could be withdrawn on demand.

In 1987, I published an article in the Austrian Economics Newsletter entitled “The ‘True’ Money Supply: A Measure of the Supply of the Medium of Exchange in the U.S. Economy.” My article was an attempt to elaborate and defend Rothbard’s definition of the money supply, especially with respect to the items he chose to include or exclude from the money supply. I called Rothbard’s monetary aggregate the “‘true’ money supply” or TMS, with the word “true” in scare quotes to emphasize the fact that the proposed monetary aggregate was true in the limited sense of approximating the theoretical definition of money as the general medium of exchange. Thus for an asset to be included as a component of TMS, I argued that it must be either generally and routinely accepted in exchange as a final means of payment for goods and services, like dollar bills issued by the Federal Reserve or immediately redeemable for dollar bills at par on demand by the depositor. All of the items in TMS meet this criterion. Or, if we wish to put it in these terms, all components of TMS are “money of zero maturity,” dollars that are instantly accessible by their owners at par value.

Sometime after I published my article, Rothbard and I agreed that we should delete the savings component of life insurance policies, mainly for practical reasons. Besides being controversial, it was difficult to acquire the data on this series necessary to calculate TMS in a timely manner. Also, Professor Timberlake, a prominent monetarist, had claimed that by including this item in the money supply Rothbard had deliberately overstated the inflationary nature of the 1920s. However, in defending Rothbard, I recalculated the TMS series for the 1920s without the life insurance component and found that it made very little difference to the growth rate of the money supply. I also found that several authors of mainstream money and banking textbooks in the 1960s and 1970s routinely included this item in their broader definitions of the money supply or as near-moneys. Nonetheless, TMS no longer includes the net cash values of life insurance.”

A money-substitute is a claim on money payable on demand at par. If the claims are backed fully by actual money, then the claims are money-certificates. If not, the excess (unbacked) claims are fiduciary media.

Look at the the diagram in Appendix B (page 231) here. It gives the arrangement.

Commercial paper is not payable upon demand so it’s not a money-substitute.

A money-substitute is a claim on money payable on demand at par. If the claims are backed fully by actual money, then the claims are money-certificates. If not, the excess (unbacked) claims are fiduciary media.”

That sounds to me like a clear statement that if commercial paper were to become a generally accepted medium of exchange, then it would become money proper, and thus add to the money supply. Which means a society with full reserve banking can have unsustainable booms and thus business cycles.

Keshav, how would a 100% reserve bank redeem at par a time deposit if the loan hasn’t already been paid back? You keep wanting to ignore why the “redeem at par, anytime” part of the equation is important.

Dan, the “redeeming at par” stuff is part of the definition of money substitutes, not part of the definition of money proper. The definition of money proper is simply “a generally accepted medium of exchange”. So if commercial paper was a generally accepted medium of exchange, it would be money proper. End of story.

Dan, I think if there was a society with two generally accepted media of exchange, say Dollars and Euros, and the number of Euros were to suddenly increase, that can cause inflation in a way that distorts credit markets and thus creates an unsustainable boom. And that remains true even if Euros cannot be redeemed for Dollars. (Though you may be able to go to a Western Union or something and trade Dollars for Euros.)

If that is correct, then it will be equally correct if the second generally accepted medium of exchange is commercial paper rather than Euros. In fact you can imagine two alternate Universes, one Universe where a society uses Dollars Euros in a such way that the Euros create an unsustainable boom, and a second Universe where everyone does the exact same actions which created the unsustainable boom in the first Universe except every transaction involving Euros is replaced with a transaction involving commercial paper. Then I claim that if there is an unsustainable boom and a business cycle in the first Universe then there’s must be an unsustainable boom and a business cycle in the second Universe. Because everyone’s actions in both Universes are the same, and what is a business cycle except people’s actions?

“Dan, I think if there was a society with two generally accepted media of exchange, say Dollars and Euros, and the number of Euros were to suddenly increase, that can cause inflation in a way that distorts credit markets and thus creates an unsustainable boom.”

So do I, if the new Euros are funneled into the economy through the loan market. That’d either need to happen with FRB or some counterfeiting scheme.

“Then I claim that if there is an unsustainable boom and a business cycle in the first Universe then there’s must be an unsustainable boom and a business cycle in the second Universe. Because everyone’s actions in both Universes are the same, and what is a business cycle except people’s actions?“

Sure, if commercial paper was just a defacto demand deposit in a fractional reserve system, then, yeah, it could create a business cycle.

None of that changes the fact that trading time deposits that are not redeemable at par anytime doesn’t cause the business cycle. I don’t know what else to say other than suggest some reading material.

Point is that if you want to develop some theory that suggests the cause of the business cycle is from time deposits, backed by actual savings, being traded on secondary markets, then that’s fine. You can try to develop that theory. I don’t think it will be right, but have at it. But it’s not ABCT.

Dr. Murphy,
Thanks for the reply. I withdraw any claims I made that you would support the idea that commercial paper would be considered money or fiduciary media by von Mises. But at issue is the ability to affect interest rates. I claim commercial paper, along with a whole host of other agreements between counter parties can radically affect credit rates. The 2008 financial crisis proved as much. That didn’t come about because of banks creating ever more fiduciary media. It came about because they created loans, securitized them and sold off the securities for cold cash. The process would have worked fine with 100% reserves. I therefore claim von Mises focus on FRB’s facilitation of fiduciary media creation is too narrow. Mises argument seems to be that money creation by non bank counter parties is self limiting but banks have unlimited capacity to create fiduciary media. The 2008 mortgage bond crisis demonstrates neither of these suppositions by Mises are true. But, if you want to put the screws to that kind of market driven money creation you can kiss a big chunk of financial freedom good bye.The invisible hand just vanished.

“That sounds to me like a clear statement that if commercial paper were to become a generally accepted medium of exchange, then it would become money proper …”

Mises says, in Human Action:

“Earlier economists applied a different terminology. Many were prepared to call the money-substitutes simply money, as they are fit to render the services money renders. However, this terminology is not expedient.”

Just because something is “fit to render the services money renders” does not make it money.

Therefore, “money proper” can only be a commodity – something that has a use-value to someone.

Paper notes can never be money propler, and therefore a 100% reserve banking system (based on paper notes) could not cause the business cycle.

Capt., free bankers like Selgin and White would disagree with your notion that the business cycle would occur in 100% reserve banking system in the way you’ve discussed. Well, unless they’ve written something I’ve never seen before, that is. But as far as I’ve ever seen nobody in the Austrian camp on either side of the argument would support your position here. Not that that makes it automatically wrong, but it’s a whole new theory to the business cycle that has almost nothing to do with ABCT.

Ok I think I understand more, it’s the distinction of the future ‘accepter’ of the claim not themselves entering the ‘contract’ with the bank, and believing they have instead recieved money proper?

In a free society, wouldn’t the note itself be understood as merely a claim on that bank, and therefore trade at some discount based on the perceived reputation?

For instance, if gold is money, the fiduciary media is readily distinguishable and so why doesn’t the public take this into account?

I’ve actually emailed you in the past about this issue, but is part of the issue that ABCT assumes that most market actors are completely unaware of the ABCT phenomenon in the first place, and so don’t take any of the necessary or obvious precautions that they would if they accepted ABCT as fact? Similar to how knowledge of germs changed our behaviour patterns.

“I’ve actually emailed you in the past about this issue, but is part of the issue that ABCT assumes that most market actors are completely unaware of the ABCT phenomenon in the first place, and so don’t take any of the necessary or obvious precautions that they would if they accepted ABCT as fact? Similar to how knowledge of germs changed our behaviour patterns.“

OK, if your question wasn’t about market actors having knowledge of ABCT and how that would change behavior, then the article I linked to isn’t appropriate.

OTOH, the article does explain why you are wrong when you say ABCT assumes most market actors are unaware of ABCT, and don’t take any precautions to prepare for it. ABCT doesn’t assume market actors have knowledge of it or don’t have knowledge of it. In fact, many Austrians have explained that even if everyone understood ABCT perfectly it wouldn’t prevent the business cycle from happening under FRB. So I guess there is that in defense of me posting an article that you didn’t seem to understand why it was relevant to your comment.

That’s strange, it’s almost as if the article you linked is explicitly about entrepreneurs reacting to fed policy, as opposed to market actors (i.e. everyone, not just entrepreneurs) reacting to changing monetary conditions in a free society with competing currencies, and competing bank notes denominated in the various currencies.

Or do you think that distinction is irrelevant? Look at the context of my question, Dan.

The article you linked is tangential. Just like every point I have ever seen you make on this blog.

“That’s strange, it’s almost as if the article you linked is explicitly about entrepreneurs reacting to fed policy, as opposed to market actors (i.e. everyone, not just entrepreneurs) reacting to changing monetary conditions in a free society with competing currencies, and competing bank notes denominated in the various currencies.”

Seriously? If you can’t see how you’re question is basically the “rational expectations objection”, and how that article addresses it, and links to articles from Garrison and Murphy that address it more indepthly, then I don’t what to say.

Great debate. I thought both you and George made some great points (although he was wrong about It’s a Wonderful Life; the bank run scene and the part where they lose the $8,000 were two separate and unrelated incidents).

Ultimately I think the only way to know which of you is right would be to adopt free banking and see what happens to reserve rates.

Yes, the “bank run scene” (which is a slight misnomer) had nothing to do with the $8000. In fact the “bank run scene” is based on, of all things, an *actual* callable loan! Let me explain. What George Bailey was running was called “Bailey Building and Loan” (BBL), and it was not an actual bank. It seems like it was some kind of credit union, where all the depositors are shareholders in BBL. And if you want to take your money out of BBL, you fill out a form and you only get your money back after 90 days. (If you need money sooner than that you need to get a loan from BBL.)

In any case, BBL had taken a callable loan from an actual bank to finance its operations. Now this being the Great Depression, there was a bank run on the actual bank. And in an attempt to resolve the bank run, the bank called BBL’s loan. So BBL scrambled to pay the bank immediately, leaving BBL very low on reserves. Potter used this as an opportunity to try to take over BBL, and he told the community “BBL is insolvent, so if you want to get any of your money back, I’m willing to buy any shares of BBL for 50 cents on the dollar.”

This caused a panic among the community, and they converged on BBL and demanded to get all their money back, and threatened to sell their shares to Potter if they didn’t. This prompted George Bailey to make his famous speech where he basically says “I don’t have your money, your money’s all been lent out to fellow members of the community. Do you really want me to foreclose on them to get your money back? And anyway, if you want your money back, the procedure is you need to fill out a form and wait 90 days to get it back.” And then he offered to give a loan to anyone who desperately needed money right now. And the community cooperated and didn’t sell their shares to Potter.

By the way Bob, would Bailey Building and Loan technically be an example of full reserve banking? Since it doesn’t involve demand deposits; you can only withdraw your money 90 days after declaring your intention to withdraw money.

Actually my current understanding is that Selgin’s view on FRB is that it basically works like an insurance system where funds are pooled together. With FRB savings are pooled together to be used for investment that otherwise couldn’t be because they are needed for each individual party as rainy day funds on demand for unforeseeable needs.

But by pooling them together in banks most of it, say 90%, can be used (loaned out) while no one needs to worry not to have his rainy day funds available at all times under normal conditions. On average say 10%.

Obviously I agree that in times of a real shock when more than 10% are really needed that would be a problem which wouldn’t be for a 100% system. But we are not talking about real shocks when we talk about the Boom & the Bust. At least I don’t see how under normal conditions this would lead to artificial Booms & Busts as the investment would come from real genuine savings, so the interest rate was lower for a reason.

Loaning out real genuine savings doesn’t create new money entering via the loan market. FRB does. That is the important distinction. See the quote I posted from the article in my response to Michael.

It seems a lot of peoole are getting tripped up by analogies used to describe FRB. Call it insurance, call loans, or whatever else, but it doesn’t change the fact that FRB creates new money entering through the loan market. Selgin, himself, concedes that Mises would side against him on this issue in the comments on that article. I think it’s important that Austrians realize that Selgin is saying ABCT as described by Mises is wrong and needs to be reworked. It’s not simply a minor disagreement amongst friends. If you want to say Mises is wrong about ABCT then you better come with more to the table than “let’s call it call loans or insurance”. Selgin offers his reasoning for why he doesn’t think FRB causes the business cycle, and what he believes does in his writings. I think his argument is weak, but he does make one. That is what people supporting him need to do as well.

Well, I think you don’t fully understand what I meant in the other thread. But that is not the point here. Now I am taking part in the discussion because I like to understand it the best I can as well. So I hope you can tell me where I am wrong. I want to make a numerical example to emphasize what I really mean, because yes FRB necessarily drives down the interest rate. But with real savings that actually are available as long as it is not subsidized via a Central Bank.

1. Scenario: No CB, no FRB. People save 20% of their income in demand deposits. This results in a market interest rate of 7%.
2. Scenario: No CB, no FRB. People save only 10% of their income in demand deposits. This results in a market interest rate of 5%.
3. Scenario: No CB, no FRB. People save only 1% of their income in demand deposits. This results in a market interest rate of 3.5%.
4. Scenario: No CB, but with FRB. People save 20% of their income in FR demand deposits. Reserve ratio 50%. This results in a market interest rate of 5%.
5. Scenario: No CB, but with FRB. People save 10% of their income in FR demand deposits. Reserve ratio 10%. This results in a market interest rate of 3.5%.
6. Scenario: With CB and with FRB. People save 10% of their income in FR demand deposits. Reserve ratio 10%. This results in a market interest rate of 2%.

So in my current understanding there is no problem in all cases but scenario 6. And cases 2 and 4 result in the same interest rate just as 3 and 5 do. And as long as there is no real shock 4 and 5 are fine and they do not start an artificial boom, the interest rate is that low because those funds really are there for loaning as they are in cases 2 and 3.

Real savings in scenario 3 drive the interest rate down to 3.5%. And the same is true for scenario 5. There is no “new” money that enters the system. Only in scenario 6 new money enters the system by a CB who through open market operations increases the amount of money so that the interest rate is driven below 3.5% to an arbitrarily defined 2%. And by doing that the CB started an artificial boom that will turn into a bust at some point.

Think about farmers who save 10% their grains for uncertain needs, but together on average only ever use 1%, so the other 9% are uselessly stocked. If those 9% were used to grow more corn, the economy would be that much bigger next year. Every single farmer alone is not able to do this on his own because every single farmer might need his 10% individually, but by pooling funds together farmers (like taking out a fire insurance) are able to do that.

As far as Mises and Murphy would argue, unless I’m misunderstanding ABCT, FRB is the cause of the business cycles, so in situation 4, 5, and 6 you are going to have a business cycle. How big depends on how much new money is entering through the loan market.

OK, I just wanted to make sure. A lot of people like to point out the business cycle predates central banks as a way to criticize ABCT without realizing the theory is about how it’s FRB that is the real problem. I was deep into this stuff back in 2008 to maybe 2011, but I haven’t really been studying it much since then, so I’m rusty. This debate has caused me to start rereading Jesus Huerta de Soto’s Money, Bank Credit, and Economic Cycles https://mises.org/library/money-bank-credit-and-economic-cycles

I’d definitely recommend it if you’d like to see why ABCT puts the blame on FRB, and not just central banking.

Ok, I know how it is if you work your mind into something, then you form an opinion based on that, and later you lose the details and only the opinion remains, and it is suddenly kinda tricky to justify that opinion to others…

De Sotos book was on my reading list for a while, but never came around to read it, maybe it is about time.

Yeah, a lot of economic topics I can just read a quick article on to knock the rust off, but something like business cycle theory takes a bit more work, like rereading a 900 page book. It’s kind of like chess for me. I used to be really good, and I still get what is needed to be great and how to get there, but sit me in front of a chess board and I don’t see the game with the same clarity I once had.

Bob, do you think it would be problematic if fixed-term bond notes circulated as a medium of exchange? Or is it only problematic if callable loans circulated as a medium of exchange? If the latter, what’s the difference?

2. FRB has the advantages over 100% reserve that it a) lowers the cost of supplying money b) allows banks to adjust the size of the money supply to match demand so avoiding the necessity of nominal prices changing every time demand for money changes.

And he clearly thinks that 2 outweighs 1.

Do you agree that the things listed in 2 are indeed advantages that just don’t happen to outweigh the disadvantages or do you think these claimed advantages are spurious ?

“The central crisis of IAWL is caused when Uncle Billy goes to Potter’s bank to deposit $8,000 for the Building and Loan and absentmindedly leaves the money behind. As George tells Uncle Billy after hearing about the lost deposit, ‘Do you realize what this means? It means bankruptcy and scandal, and prison!’ … The real thief, of course, was Mr. Potter, who knew the $8,000 belonged to Uncle Billy and yet kept it for himself.” (http://blog.acton.org/archives/84030-the-economics-of-bedford-falls-part-i.html)

It was thanks to Uncle Billy’s blunder that the dastardly Mr. Potter knew he might put the BB&L in his clutches by spreading the word that it was insolvent.

George Bailey said ”You’re thinking of this place all wrong, as if I had the money back in the safe,” he tells onlookers. “The money is not here….your money is in Joe’s house…and the Kennedy house. “. But because BB&L reserves the right to require 60 day notice for withdrawals (and routinely waived that requirement) that’s not FRB? The von Mises apostle peddling that idea is a crooked as old man Potter.

I don’t feel like reading through that article at the moment, but if he’s arguing that a 60 day notice, on it’s own, changes things, then I don’t think that is correct. Murphy can correct me if I’m wrong, but the issue is when you expand the money supply and then it enters the economy through the loan market. If I deposit money in a FRB, and don’t touch it for 60 days of my own volition it still is expanding the money supply, and that new money is still entering the economy through the loan market. I see no difference between me depositing money into a FRB and willingly not touching it for 60 days, or them having a rule I can’t touch it for 60 days, as far as the business cycle is concerned.

So Dan, do you think that fixed-term bond notes being a medium of exchange would give rise to a business cycle, in the same way that you think callable loan notes being a medium of exchange would give rise to a business cycle?

So Dan, then the issue isn’t fractional reserve banking at all. So do you think you could have an unsustainable boom, a business cycle, etc. in a society with full reserve banking where fixed-term bond notes serve as a medium of exchange?

Dan, it’s simple. Person A lends the Bank $1000, and Bank hands person A a $1000 fixed-term bond note. Then the Bank lends the actual $1000 to person B. So now person A and person B both have $1000 that they can freely spend in stores, and there was no fractional reserve banking involved.

OK, I just wanted to make sure you were asking me about a situation where FRB is actually taking place rather than a situation where bond notes are being traded on secondary markets. So, yes, the example you described is FRB and would result in a boom/bust cycle.

I mean, that’s not how things would work in practice with a FRB, considering the bank took in $1000, immediately turned around and loaned out 100% of the money, and now has no money to back person A’s notes when someone wants to redeem them. But, nonetheless, it’s FRB.

Dan, what I described is full-reserve banking, not fractional-reserve banking. In full-reserve banking, banks are allowed to lend out time deposits but not demand deposits. You can ask Bob or anyone else and I’m confident they’ll back me up on this.

I’m confident that Murphy will back me up. You didn’t just describe a situation where a timed deposit was loaned out. You described a situation where a timed deposit was loaned out and the note was able to circulate in the economy as good as money. That is functionally the same exact thing as what FRB do with demand deposits.

If you’d like to see why they don’t have a 100% reserves in your situation, imagine a bank with only two customers. Person A loans the bank $100, and in return receives a note that is as good as money. The bank now has $100. Then the bank loans that $100 to person B. Now the bank has $0. What reserves do they draw on when person A spends his note at the grocery store and they deposit it at Bank 2, and this second bank demands the first bank to redeem their note?

Dan, we’re talking about a fixed-term bond note here. It can only be redeemed at maturity. So person A makes a 1-year loan to the Bank, and the Bank makes a 1-year (or less) loan to person B, and then by the time person A (or whoever they gave the note to) is able to redeem the note, the Bank has already gotten the money back from person B.

So this is full-reserve banking, not fractional reserve banking. Because is no lending of demand deposits.

Keshav, you’re trying to have your cake and eat it too. If the note can’t be redeemed until maturity, then it’s not circulating in the economy as good as money. I’ll grant you that you could trade the note for money, or barter it for goods, but the holder of the note doesn’t have in his possession a note that is as good as money. He has a promissory note. That doesn’t expand the money supply.

So, IOW, if you’re asking me if the business cycle will result from a bank taking money from person A, giving him a note that can’t be redeemed until 90 days or whatever, and loaning that money to person B for the same time frame, then, no, that doesn’t cause the business cycle. Even if person A is able to sell his note on the secondary market or use it to barter. As long as person A, or whoever holds the note, can’t redeem the note until it is repaid then it doesn’t cause the business cycle. That is simply a timed deposit and is perfectly fine.

If you’re looking for an example where you could see a boom/bust without FRB, you could look at a situation where someone counterfeits a bunch of money and then lends it out. That would cause the business cycle. So, you could think of it this way; Increasing the money supply and funneling it into the economy through the loan market causes the business cycle. FRB does this, and will cause the business cycle according to ABCT. And adding in a central bank simply makes this effect worse.

So, increasing the money supply and putting it into the economy through the loan market is the culprit, and could be caused by more than FRB, like with counterfeiting, but FRB, by its nature, will cause the business cycle, and I can’t think of anything off the top of my head, beyond counterfeiting, that would cause it outside of FRB.

“Keshav, you’re trying to have your cake and eat it too. If the note can’t be redeemed until maturity, then it’s not circulating in the economy as good as money. I’ll grant you that you could trade the note for money, or barter it for goods, but the holder of the note doesn’t have in his possession a note that is as good as money. He has a promissory note. That doesn’t expand the money supply.” Dan, why shouldn’t the note be considered part of the money supply? It can be freely used to buy things, just like dollar bills. So why doesn’t it have identical economic effects as dollar bills?

I can barter with just about anything; shuffles, cigarettes, drugs, etc. Being able to barter something or trade it doesn’t increase the supply of money in the economy. The note, if it is not redeemable until the loan is repaid, is not circulating in the economy as good as money. It’s a promissory note. A claim on money in the future. You can only trade it to those willing to either wait until the note is claimable to get paid, or someone who plans on trading it to someone else willing to wait to be paid. It’s not something you can just put in your bank account and start spending it however you want.

Maybe Murphy can give you a better explanation if that above is not satisfactory, because I’m not really sure how better to say that being able to simply trade an asset for good and services doesn’t increase the supply of money.

What about this. Forget a bank. Let’s say you lend me $100 and I give you a piece of paper that says “I promise to pay the holder of this piece of paper $100 on or after X date.” And then I turn around and pay my employee that $100 immediately. Can you see how that piece of paper, even if you can get someone to trade you goods and services with it, which would be difficult unless they knew me and trusted me, is not money? If you can see it in this example then you should be able to see it in an example when the promissory note is from a bank, even if that bank is more easily trusted and people are more willing to trade you good and services for it. I promissory note is not money, but a promise to pay the holder of the note money in the future.

Dan, you might be able to find occasional people, (like a few smokers) who might be willing to barter something for cigarettes. But they’re not a medium of exchange. You can’t walk into a grocery store with a pack of cigarettes and buy stuff.

I’m saying, imagine a society where fixed-term bond notes (redeemable only on maturity) circulated as an actual medium of exchange. Would such a society have unsustainable booms and a business cycle?

Because a promissory note, as you’ve described, doesn’t circulate like money in every way. Can you deposit it in your bank account? Can you go into a bank and swap it out for money daily, free of charge? No, because it is a promise to pay a certain amount of money to the holder of the note on a future date. It’s not money, and it’s not a money substitute. It’s an asset, though. And you can trade assets on secondary markets or in barter situations with no impact on the money supply.

I’m obviously not doing a very good job of making this distinction for you, and if that excerpt from Mises doesn’t help, I doubt I’ll do better.

One last try. Let’s say there are 3 people in an economy. Everybody has $100. Person A loans Person B $100 and gets a note that can be redeemed in 1 day -We’ll ignore interest to keep matters simple-. Now Person A has a promissory note for $100 in 1 day, Person B has $200 dollars, and Person C has $100.

Then Person A exchanges his promissory note for a shovel with Person C. Now Person C has a promissory note and $100, Person A has $0, and Person B has $200.

The next day Person C redeems his note with Person B. Now Person A has $0, Person B has $100, and Person C has $200. So in the beginning there was $300 in the economy and at the end there is $300 in the economy. The only thing exchanging the promissory note did was change who Person B owed money to. It didn’t increase the amount of money in the economy by even a penny.

“Because a promissory note, as you’ve described, doesn’t circulate like money in every way.” Dan, I am asking you to imagine a society where it *does* circulate like money in every way.

“Can you deposit it in your bank account?” Yes, I am envisioning a society in which you can deposit the note in bank accounts.

“Can you go into a bank and swap it out for money daily, free of charge?” That’s a weird question. Can you go into a bank and swap money out for money?

“So in the beginning there was $300 in the economy and at the end there is $300 in the economy.” Yes, it is true that after the note expires, the money supply returns to its old level. But *while* the note hasn’t expired, the note circulates in the community the exact same way that cash circulates in the community. So the note and cash have identical effects on the economy.

Dan, let me put it this way. Here’s the explanation Bob gives in the debate for how fractional-reserve banking causes an unsustainable boom. In a society with full-reserve banking, entrepreneurs can use interest rates as a price signal for whether they should start a new business. Because the interest rate reflects the willingness of the community to forego consumption and lend money to the entrepreneur. But in a society with fractional-reserve banking, depositors can go on a spending spree at the same time that entrepreneurs are investing in their business. So entrepreneurs will get inaccurate signals from the interest rate, because it doesn’t really reflect depositors’ willingness to forego consumption. So there’s an unsustainable boom.

If that explanation is correct, then it seems to me that the society I’m envisioning, in which fixed-term bond notes can be used for every purpose that money can be used for, would have exactly the same sort of unsustainable boom. Because depositors will be able to go on a spending spree at the exact same time entrepreneurs are investing in businesses. And so entrepreneurs will get inaccurate signals from the interest rate because it won’t reflect depositors’ willingness to forego consumption.

“Dan, I am asking you to imagine a society where it *does* circulate like money in every way.”

Keshav, I’ve already stated that if it circulates in the economy as good as money, then it’s the same thing as FRB and would cause the business cycle. But what would be the point of doing that with a timed deposit? If Person A can loan the bank $100 and get a note that matures in X days in return, and then turn around and swap the note out at face value immediately, what was the point? That’s FRB with demand deposits in all but name.

“If that explanation is correct, then it seems to me that the society I’m envisioning, in which fixed-term bond notes can be used for every purpose that money can be used for, would have exactly the same sort of unsustainable boom. Because depositors will be able to go on a spending spree at the exact same time entrepreneurs are investing in businesses. And so entrepreneurs will get inaccurate signals from the interest rate because it won’t reflect depositors’ willingness to forego consumption.”

You’re right it would. That’s fractional reserve banking. The problem is you’re describing FRB and insisting that it’s not FRB.

It’s the same thing over and over. People keep describing what FRB does in practice, and then think by simply calling their deposit a bond, call loan, etc. that that will somehow change reality.

If I have a bond note that I can use as money in every way, including going to a bank and swapping it out for cash any time I want without cost, then I don’t have a bond. That’s not how bonds work. If society insisted on calling those notes, bonds, fine, but it is just semantics at that point. What we would have is FRB, and those “bond notes”, “call loans”, or whatever, are what we call demand deposits in the current world we live in.

“If I have a bond note that I can use as money in every way, including going to a bank and swapping it out for cash any time I want without cost, then I don’t have a bond. That’s not how bonds work.” Dan, I’m not saying it’s possible to “redeem” the bond for cash in the society I’m envisioning. I’m saying it’s possible to trade the bond for cash. That doesn’t contradict the nature of how bonds work in anyway.

And? You said it is no different than money, right? So, I give the bank $100 for a bond paying 5%. Then I deposit it into my checking account. Then I pull $105 out of the ATM. At the same time, the bank has loaned out the $100 I gave them.

It’s nonsense, but this is the world you came up with. So, yes, in that example, you’d be increasing the money supply and putting it into the economy through the loan market, and this would cause the business cycle.

Anyway, the point is, the scenario I’m envisioning has nothing to do with fractional reserve banking because there is absolutely no lending of demand deposits. So it seems like under your view, fractional reserve banking is not the real culprit at all. It’s deposits, whether demand-deposits or time-deposits, as money that is the real issue.

“Anyway, the point is, the scenario I’m envisioning has nothing to do with fractional reserve banking because there is absolutely no lending of demand deposits. So it seems like under your view, fractional reserve banking is not the real culprit at all. It’s deposits, whether demand-deposits or time-deposits, as money that is the real issue.”

No, again, the culprit is creating new money and lending it out. I’ve said this repeatedly. I’ve linked you to books that spell it out. I’ve shown where Mises explicitly states this.

The problem you’re having is you’ve came up with the most convoluted FRB of all-time but insist on calling it a 100% reserve bank. So, let me try again, because I can’t see how you aren’t getting this.

Person A lends the bank $100 and gets a note for $105. The bank now has $100.

Then bank then lends $100 to person B. The bank now has $0 in reserve.

Person A goes to the bank and deposits his note into his checking account, and pulls out $100 from the ATM.

Where did the $100 come from, Keshav. In my simple model, to make the point clear, the bank started with $0, got $100 from A, and then went back to $0 when they made the loan with B, so how are they going to give person A $100 when he deposits his bond note and demands cash?

“Bank 1 starts with $0. A lends them $100 and gets a $105 bond note in return. Bank 1 lends $100 to B. Now Bank 1 has $0 in reserve.

A spends bond note to buy $100 worth of food. The grocer deposits the bond note with with Bank 2. Bank 2 goes to Bank 1 and says “Give is $100 for your $105 bond note. It’s as good as money, right?”

How does Bank 1 give Bank 2 $100 when they have no money at all? How are they a 100% reserve bank when they literally have $0 in reserve?” Dan, Bank 1 only has to give the money at maturity. Before then, Bank 1 has no obligation to give a penny to Bank 2. All Bank 1 needs to do is make the term of the loan to B less than or equal to the term of the bond note it gave A. So by the time Bank 1 needs to pay Bank 2, it will have the money it needs to do so.

“Dan, Bank 1 only has to give the money at maturity. Before then, Bank 1 has no obligation to give a penny to Bank 2.“

OK, then that is just a regular old time deposit, and it has no effect on the business cycle.

You keep moving the goal posts on me. You’ll say “Imagine it does circulate like money in every way.” Then I bring up a situation where someone deposits it into their account and immediately pulls out a cash equivalent, and then you’re saying “Well it doesn’t do that.” If it cant be redeemed until maturity without penalty then it’s not just like money. Plain and simple.

So, again, if it is just a time deposit that can’t be redeemed without penalty whenever you want then it’s not going to cause the business cycle. If it can, then it’s a de facto demand deposit and will cause the business cycle.

“You keep moving the goal posts on me. You’ll say “Imagine it does circulate like money in every way.” Then I bring up a situation where someone deposits it into their account and immediately pulls out a cash equivalent, and then you’re saying “Well it doesn’t do that.” If it cant be redeemed until maturity without penalty then it’s not just like money. Plain and simple.” Dan, I assure you that I’m not moving any goal posts. I have been consistently describing one scenario this entire time. I am describing a society where fixed-term bond notes can be freely traded for dollars, goods, and services at any time. But they cannot be *redeemed* by the bank who issued them until they reach maturity.

But you can do anything with them you can do with cash: you can deposit them in bank accounts, withdraw them from bank accounts, buy oranges with them, hire maids with them, etc.

“But you can do anything with them you can do with cash: you can deposit them in bank accounts, withdraw them from bank accounts, buy oranges with them, hire maids with them, etc.“

OK, then answer this for me. Bank starts with $0. Person A lends Bank $100 and gets $105 note that can be redeemed in 90 days. Bank lends $100 to Person B. So Bank now has $0.

Then Person A trades note to Person C for food. Person C opens an account with Bank and deposits note. Can Person C go to the ATM and pull out $20, or since the bank only has the note in its possession and $0 will they just give him the note back? Or could Person C go to the grocery store and use his debit card to buy, say, $60 worth of food?

If you say he can pull out cash from the ATM, then where did the money come from? If he can go and spend $60 on his debit card, then where did the money come from? And what would the grocery store have in their position if it wasn’t dollars?

“Dan, person C can’t go to the particular bank that has $0 in cash and get cash from them. But he can go to other banks and they’ll be perfectly willing to trade the note for cash.”

How’s that going to work? These are 100% reserve banks, right? Let’s say there is Bank 2, and Bank 2 has Person D as a customer, and he has $1000 in his checking account. If Person C trades his note for $105, or any other amount, Bank 2 can’t give him cash without sacrficing it’s 100% reserve status.

“Dan, I just meant that a bank or other financial institution that had cash of its own, as opposed to depositors’ cash, would be willing to trade its cash for bond notes.”

Alright, but that is no different than trading it with any other random person on the street. The fact that they are a bank would be inconsequential.

But, you also said that someone could deposit the note into a checking account. So, you still need to explain what happens when Person C deposits their note into the bank, and goes to the ATM or uses their debit card at the grocery. The bank can’t give them cash without pulling it from someone else’s checking account which would mean they are no longer a 100% reserve bank, and what are they giving the grocery store owner when the debit card is used? Are they giving them cash? Same problem as the ATM. They’d have to draw that cash from someone else’s checking account because Person C only deposited the note. Explain how you can deposit a note and then go about spending it without the bank having to cease being a 100% reserve bank.

“OK, in that case it would not cause the business cycle. That’s just a regular old time deposit with a convoluted way of trading it.” Dan, why would it not cause a business cycle? If it can be used in all ways that dollar bills can be used, why would it not have identical economic effects as dollar bills?

The mechanism by which fractional reserve banking is supposed to cause a business cycle is that an entrepreneur is getting an inaccurate market signal from the interest rate. The interest rate is supposed to represent the willingness of depositors to forego consumption and lend their money to the entrepreneur. But under fractional reserve banking, depositors don’t need to forego consumption at all when putting their money in a bank; they can go on a spending spree at the same time the entrepreneur chooses to expand his business.

Well, in the society I am envisioning, the exact same thing can take place. Person A can go on a spending spree with the $100 bond note at the same time person B can expand his business with the hundred dollar bill. A bond note can do everything that a dollar bill can do, so you’ve effectively increased the money supply by $100. So why wouldn’t you have an unsustainable boom?

“Well, in the society I am envisioning, the exact same thing can take place. Person A can go on a spending spree with the $100 bond note at the same time person B can expand his business with the hundred dollar bill. A bond note can do everything that a dollar bill can do, so you’ve effectively increased the money supply by $100. So why wouldn’t you have an unsustainable boom?”

It’s because savings is taking place to back that bond note. Person A trading the note to Person C simply swaps assets. It doesn’t change the fact that the supply of dollars or dollar substitutes in the economy has not changed because the note can’t be redeemed until the date of maturity.

You’re getting hung up on being able to exchange a note and thinking that is the same as not having Person B’s loan backed by savings. What’s happening, though, is you’ve just envisioned a society that accepts trading promises. Think of it without the note. Dan loans Keshav $100, and gets nothing but Keshav’s word that he will pay him back. Dan goes to the grocery store and says, “Hey, you’re cool with me taking $100 worth of groceries, right? I’m good for it. Keshav is going to pay me $100 down the line, and I can either give it to you then, or have Keshav pay you directly. Sound good?” Are you telling me that spoken words just expanded the money supply?

That is what is happening in the society you envision. People are trading on promises to pay once the initial loan has been repaid. Just because people play hot potato willingly with that loan doesn’t change the fact that whoever currently holds the loan hasn’t been paid until the loan matures.

“It was thanks to Uncle Billy’s blunder that the dastardly Mr. Potter knew he might put the BB&L in his clutches by spreading the word that it was insolvent.” George, you make this claim in the debate as well, and it’s not accurate. The incident with Uncle Billy and the $8000 happens long after the bank run scene.

The thing that Mr. Potter uses to cause a run on Bailey Building and Loan is a callable loan that Bailey Building and Loan took from an actual bank, which was called by the bank when it encountered a run of its own.

Some might say it’s FRB because the notes are backed by nothing at all (zero reserve banking?). But others might say that they are 100% backed because Bitcoin is a legitimate store of value. Some might say they are just another way to hold currency. They are not being issued by loaning money, rather you have to buy them with some other type of money so does that make them neutral in their effects? The amount of currency has not increased just been moved around a bit.

But what if you could put up collateral and get a loan in these notes? Notes that will be produced upon your signing of the loan contract. You’ve secured your loan with your house and now the bank issues you these notes which they loaded with Bitcoin that they’ve purchased with regular money but give them to you only backed by your property. Does this put us in the same place as with historical free-banking from an ABCT POV?

Does this even fall under the term “banking”? Are they banknotes or bunknotes?

What if this goes big and these notes start getting issued and accepted everywhere, what might be the possible problems?

Bob, can you please answer this question: you said it would be problematic if callable loan notes were a medium of exchange. Would it also be problematic if fixed-term bond notes were a medium of exchange?

Keshav, I don’t want to wade into this big debate you’re having. But the general principle is: If individuals or firms are able to effectively “create money” that hits the loan market early on, then it can push interest rates below the “natural” level and cause an unsustainable boom.

Does anyone know what this is? Can anyone know at any given time what this should be?

Same question for money: Can anyone prove what the optimum amount of money is at any given time in any given place? A real place with real people not the “suppose you have ten people on an island” thought experiment.

—unsustainable boom—

Scotland seems to have “suffered” through a 100+ year sustainable boom. Why doesn’t their history beat your theory?

“Does anyone know what this is? Can anyone know at any given time what this should be?”

The “natural rate” is not a specific number. Rather, it is an unfraudulent (real word?) rate that is logically derived from individuals’ time preferences.

This natural, or unfraudulent, rate is sustainable because the goods that the lent funds buy are accompanied by underconsumption on the part of the saver.

In effect, the goods that the saved money aren’t buying at the moment (or the materials that go into making them) are made available to longer term production processes.

What fraudulent (“artificially low”) rates cause is a bidding war between borrowers and those businesses which are producing what savers *are* producing at the moment.

There’s nothing wrong with a bidding war, per se, but when someone can spend counterfeit money into the economy, that is going to allow that spender to acquire goods he wouldn’t otherwise have been able to acquire, thereby reducing the supply available to others.

Reduced supply raises prices, and higher prices tend to reduce consumption spending (all other things equal), and so demand for the goods that are being bid up falls, and that threatens the profitability of the longer term production processes made possible by the “artificially low” rates.

A correction must logically take place in the longer term production processes (the ones that were affected by the bidding war; directly, or indirectly), and that’s a bust.

Thanks for answering Keshav’s question Dr. Murphy. I have a follow up question. Does ABCT tell us that in a credit market with no money creation by individuals or firms (including banks) we are assured that the economy will grow at its full potential?

My prior on this issue is that the economy is very unlikely to grow at its potential. GDP potential growth path is a function of technology.. Available credit is a function of preferences for future consumption over current consumption. Interest rates will adjust to match savings to investment but I see no mechanism that guarantees the rate of savings will support an economic expansion at the maximum sustainable rate.(unless savings is highly elastic to the interest rate.